Private Student Lending Followed Same Path as Burst Mortgage Bubble

The private student loan market shares some similarities with the real estate market before the mortgage bubble burst, according to a report released Friday by the Consumer Financial Protection Bureau and U.S. Department of Education.

Specifically, private student loan origination bubbled up rapidly during the last decade, from less than $5 billion in 2001 to more than $20 billion in 2008, and then precipitously declined to less than $6 billion in 2011.

During that growth period, underwriting standards loosened, with the percentage of loans to undergraduates made without school involvement or certification of need growing from 40% to more than 70%, the report said.

“As a result, many students borrowed more than they needed to finance their education. Additionally, during this period, lenders were more likely to originate loans to borrowers with lower credit scores than they had previously been. These trends made private student loans riskier for consumers,” the CFPB said in the report.

Private lenders bundled and resold student loans to investors to avoid losing money when students defaulted, and had little concern about ability to repay at the time of origination, the report said.

Like strapped homeowners, private student loan borrowers are struggling to repay their loans. Default rates have spiked significantly since the financial crisis of 2008, with more than $8 billion worth out of a total of $150 billion outstanding.

In 2009, the unemployment rate for private student loan borrowers who started school in the 2003-2004 academic year was 16%, and one in 10 recent graduates of four-year colleges have monthly educational loan payments that exceed 25% of their income.

Underwriting has tightened on private student loans, however. Co-signers have increased from 67% in 2008 to more than 90% in 2011. In addition, in 2011, 90% of private lenders required the school to certify student need. Lenders have also increased overall credit scores within their portfolios by tightening credit standards and reducing lending to nonprime borrowers.

The study also found that many private student loan borrowers did not exhaust their federal Stafford Loan limits before turning to private products.